Edexcel​ ​Economics​ ​A-level

Unit​ ​4:​ ​The Global Economy

Topic​ ​2:​ Trade and the World

Economy
2.4 Trade liberalisation

Notes

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Types of trading blocs (regional trade agreements and bilateral trade
agreements):

Free trade area

This is where countries agree to trade goods with other members without
protectionist barriers. For example, the North American Free Trade Agreement
(NAFTA) is a free trade area, as is the European Free Trade Association (EFTA).

They allow members to exploit their comparative advantages, which increases

efficiency.

Customs union

Countries in a customs union have established a common trade policy with the rest
of the world. For example, they might use a common external tariff. They also have
free trade between members. The European Union is an example of a Customs
Union.

Common market

This establishes free trade in goods and services, a common external tariff and
allows free movement of capital and labour across borders. When the EU was
established, it was a Common Market. EU citizens can work in any country in the EU.

Monetary unions, including conditions necessary for their success:

This is sometimes called a currency union. Members of a monetary union share the
same currency. This is more economically integrated than a customs union and free
trade area. The Eurozone is an example of this.

A common central monetary policy is established when a monetary union is formed.

The single European currency, the Euro, was implemented in 1999 to form the
Eurozone.

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 Monetary unions use the same interest rate. The Euro, for example, floats against
the US Dollar and the Pound Sterling. Member nations are required to control their
government finances, so budget deficits cannot exceed 3% of GDP. This is one of the
four convergence criteria countries have to meet in order to join the Euro. The other
three are:
- Gross National Debt has to be below 6% of GDP
- Inflation has to be below 1.5% of the three lowest inflation countries
- The average government bond yield has to be below 2% of the yield of the
countries with the lowest interest rates. This ensures there can be exchange rate
stability.

The optimal currency zone is created when countries achieve real convergence.
Member countries have to respond similarly to external shocks or policy changes.
There has to be flexibility in product markets and labour markets to deal with shocks.
This could be through the geographical and occupational mobility of labour, and
wage and price flexibility in labour markets. Fiscal transfers could be used to even
out some regional economic imbalances.

Costs and benefits of regional trade agreements:

Trade creation and trade diversion

With more trading blocs, trade has been created between members, but diverted from
elsewhere. Trade creation occurs when a country consumes more imports from a low cost
producer, and fewer from a high cost producer. Trade diversion occurs when trade shifts to
a less efficient producer. Usually, a country might stop importing from a cheaper producer
outside a trading bloc to a more expensive one inside the trading bloc. Moreover,
protectionist barriers are often imposed on countries who are not members, so trade is
diverted from producers outside the bloc to producers within the trading bloc. The UK
trades mainly with the EU, at the expense of former trade links in the Commonwealth.

Reduced transaction costs

Since there are no barriers to trade or no border controls, it is cheaper and simpler to trade.

Economies of scale

Firms can take advantage of a larger potential market in which to trade. For example, the EU
has 500 million people to sell to. By specialising, firms and countries can exploit their

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comparative advantages, and the gains of efficiency and advanced technology can be
reaped.

Enhanced competition

Since firms operate in a more competitive market, they become more efficient and there is
a better allocation of resources. There could be the long run benefits of dynamic efficiency
too, although these benefits are not always spread evenly across each member.

Migration

By being a member of a Customs Union, the supply of labour is increased, which could help
fill labour shortages. However, this might mean some countries lose their best workers.

Role of the WTO in trade liberalisation:

The WTO promotes world trade through reducing trade barriers and policing existing
agreements. It also settles trade disputes, by acting as the judge, and organises trade
negotiations.

Every member of the WTO must follow the rules. Those who break the rules face trade
sanctions. In addition to trade in goods, the WTO covers the trade in services and
intellectual property rights.

As of 2015, there are 161 member states in the WTO.

Possible conflicts between regional trade agreements and the WTO:

Trading blocs might distort world trade or adversely affect those who do not belong to
them. There could be an inefficient allocation of resources as a result of policies such as the
EU CAP.

Conflicts between blocs could lead to a rise in protectionism. A common external tariff
contradicts the WTO’s principles, since although there is free trade between members,
protectionist barriers are imposed on those who are not members.

Some countries might argue that the WTO is too powerful, or that it ignores the problems of
developing countries. This could be since developed countries do not trade completely
freely with developing countries, which limits their ability to grow.

Setting up a customs union or a free trade area could be seen to violate the WTO’s principle
of having all trading partners treated equally. This is especially if a common external tariff is

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applied. However, they can complement the trading system and the WTO strives to ensure
that non-members can trade freely and easily with the members of a trade bloc.

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